Avoiding the Sequester Isn’t Rocket Science

Feb. 18 (Bloomberg) -- Democrats and Republicans in
Washington agree: It would be a disaster if the “sequester,”
with its more than $1 trillion of cuts to defense and domestic
spending, takes effect March 1, as scheduled.

Defense Secretary Leon Panetta says the reductions to his
budget would undermine national security; the cuts to already
pared-down domestic spending will set back critical needs such
as cancer research, the Head Start federal preschool program for
young children and funding for the Border Patrol. The economic
recovery would be impeded, at a cost of as many as 750,000 jobs.

President Barack Obama says the cuts “are a really bad
idea.” In a rare display of accord, House Speaker John Boehner
says the “meat axe” approach would “weaken” the nation’s
defense. Obama and Boehner were two of the authors of the 2011
sequester agreement, figuring a sensible alternative would have
emerged by now.

It hasn’t, and the sequester could kick in, even if only
temporarily. It’s a textbook case of Washington dysfunction.

Both sides created this debacle, but there is no
equivalency of blame today. Any alternative must emphasize
reductions in mandatory entitlement programs and add revenue.
Obama, publicly and privately, has left no doubt he will
surrender the Democrats’ political trump card and accept cuts in
programs such as Medicare. Republican leaders insist they won’t
give ground on new revenue, without which there can be no deal.

An impasse will be unsettling to markets and the economy in
the long run, even if deficit hawks exaggerate the severity of
the crisis.

Tenuous Outlook

“The 10-year budget outlook remains tenuous,” says Bill
Gale, director of economic studies at the Brookings Institution.
“Even if seemingly everything goes right -- in economic terms
and political terms -- we are still on the edge of dangerously
high debt and deficit levels.”

It isn’t hard to devise a feasible alternative, if the
irrational politics are put aside. First, any deficit-reduction
plan should wait two years. That’s because the deficit has
already been narrowed by almost $2.5 trillion over the next
decade. In the short term, the government needs to bolster the
shaky recovery by spending more on infrastructure and other
projects.

Then, it should put in place a long-term $1 trillion
deficit-reduction package, half of which is achieved through
entitlement cuts, one-third through tax increases and the rest
by shrinking discretionary programs, chiefly defense, which are
funded through annual appropriations from Congress. That would
send an encouraging sign to markets and help the economy, but
only if it’s a long-term plan, rather than the one-year fix that
Senate and House Democrats are proposing.

Entitlements or mandatory programs such as Medicare and
Social Security make up almost 60 percent of the federal budget,
and are the engine of chronic deficits. Getting $500 billion
over 10 years wouldn’t be pain-free, though it doesn’t have to
hurt those who can least afford to sacrifice.

The president has said he would go along with the scope of
the Bowles-Simpson deficit commission’s proposed cuts to
Medicare. That’s about $350 billion. It wouldn’t require cuts
for the most needy, but would contain a means test for more
affluent senior citizens. A sensible deal wouldn’t increase the
eligibility age and would introduce more stringent cost controls
and hit up drug companies for a little more.

Inflation Calculation

Half the remaining savings could come from changing the
formula for the cost-of-living increases for Social Security and
other inflation-adjusted entitlements. That’s a realistic
proposal if protections are carved out for the very poor and the
very elderly. The Center for American Progress has offered
workable specifics. The rest could come from cutting
agricultural subsidies and other entitlement programs.

The White House would buy this; and it has been the dream
of Republicans for years.

On taxes, Republicans contend that the fiscal cliff deal in
January, which raised taxes on the wealthy by $600 billion,
means any further revenue-raisers are off the table. A number of
party leaders also pay lip service to the Bowles-Simpson
recommendations, which proposed $1 of revenue for every $2 of
spending cuts, after eliminating former President George W.
Bush’s high-end tax cuts. If these Republicans have their way
and the sequester or any alternative to it is exclusively
spending cuts, that ratio would be more than 4 to 1.

The easiest way to get that revenue would be a plan
resembling the administration’s proposal to limit deductions to
the 28 percent rate, and then exclude charitable deductions from
that cap. That would raise more than $300 billion.

The other Republican argument is that any tax changes
should await broad tax reform. But limiting deductions wouldn’t
narrow their options or dash their hopes of using reform as a
vehicle for lowering rates. There are endless possibilities for
curbing tax breaks in a revenue-neutral measure that also lowers
rates, including scaling back big-ticket items such as the home-mortgage deduction or health-care exclusion or the preferential
treatment for capital gains. Other changes are politically
appealing, such as ending the carried-interest loophole for rich
investors or the tax breaks for the oil and gas industries.

What shouldn’t be cut is non-defense discretionary
spending, such as veterans’ programs, medical and scientific
research and education. Even without the sequester, these
programs are headed toward their lowest level, as a percentage
of the economy, since the Eisenhower administration.

An entitlements and revenue-based deal, however, would
approximate the Bowles-Simpson targets, and engender confidence
in markets and businesses. The politicians could then turn to
tax reform, immigration, gun violence, maybe a modest climate-change measure, and substantive oversight.

As a bonus, a successful deal might also lessen public
cynicism about Washington.

(Albert R. Hunt is a Bloomberg View columnist. The opinions
expressed are his own.)